The case for taxing interest
Basil Al-Nakeeb
Abstract
The focus of this paper is Western economies (the West), primarily represented by the European Union and N. America, using the US – the largest Western economy – for illustrative purposes where appropriate. It notes the failure of past attempts, using a variety of measures, to prevent banking crises from reoccurring and to improve banking survivability. Regrettably, the economic literature has not classified interest bearing debt – the primary source of financial breakdowns – as a negative externality, despite potentially representing the largest and growing negative externality plaguing Western economies. Thus, the paper investigates this cancerous negative externality and its effect on cyclicality, households, corporations, economic uncertainty, national defense, and democracy. It ascribes the growth of the debt phenomenon to a biased tax system that favors debt over equity finance. It explains the rationale of imposing Pigovian (excise) taxes on demerit goods such as alcohol to curb their consumption and argues in favor of imposing a similar tax on interest bearing debt to restrict its use. It concludes with a brief discussion of the likely effects of such a tax on the economy, forms of financing, the structure of banking, and monetary policy. The paper uses qualitative analysis to arrive at its conclusions.

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